Hesitating over HIGH-PRICED LAND

WHEN IT COMES TO BUYING farmland today, he who hesitates loses out. Steadily rising land prices, tight supply and increased investor interest are keeping land sales hot. And experts predict the trend will continue well into 2005.

This past fall, an Illinois auction brought a headline-fetching $1.825 million for a 322-acre parcel of prime farmland outside Urbana, which included a home and building site. That $5,667-per-acre price may represent the extreme of today's market prices, but it probably is not the pinnacle, say ag economists and real estate experts.

Low interest rates have been a major factor fueling steady 7 to 12% real estate price increases throughout the Midwest over the last few years. That, combined with better commodity prices recently, has got more farmers looking to expand their land base. But should you buy now?

“I don't expect farmland prices to start coming down anytime soon,” says University of Minnesota ag economist Steve Taff. “Prices have just zoomed up in the last few years, especially in the southeastern part of Minnesota, around Rochester, where there is not only interest in the land for cropping but also for retirement and recreational use.

“It's getting harder to find a pure ag market for land anymore,” he adds. “The pool of potential buyers is getting more diverse.”

More buyers with bucks

According to results of the 2003 Iowa Land Value Survey, directed by Iowa State ag economist Michael Duffy, greater demand from investors is one of the major factors in increasing land values. The annual opinion survey asks more than 1,000 real estate brokers and county land assessors to report average values for low-, medium- and high-grade farmland in their counties.

“In the early '90s, about 80% of the land sold in Iowa was purchased by farmers and about 20% by outside investors,” Duffy says. “Today, the percent of farmer buyers has slipped to 59%, while outside investors represent 34%, and new farmers just 3%. We've also seen a noticeable increase in the number of landowners who live out of state, and that trend is likely to continue.”

Many of those outside investors are looking for more stable, profitable places to invest their money than low-rate CDs or the rocky stock market, notes Dale Lattz, University of Illinois ag economist and extension farm management specialist. “Even just a 3% return from farmland is competitive and much more sound than other investment options these days,” he says.

Still other outside investors want to purchase land that will also allow them to pursue recreational interests, such as hunting. “I've seen farmers buy land in partnership with investors who are mainly interested in having a place to hunt every year,” says Kent Thiesse, vice president of MinnStar Bank in Lake Crystal, MN. “Sometimes it's even a group of people who put up half the investment dollars in order to get hunting rights to the whole acreage. They might put the more marginal acres into CRP or turn some of the wetter areas back into a wetland, and it becomes a win-win situation for everyone involved.”

Not a lot of land for sale

Another major factor in increasing land values, according to the Iowa survey, is scarcity of land on the market. “We're seeing farmland sell as quickly as it hits the market,” Thiesse says. “Sometimes it sells by word of mouth, alone, and the ad never even makes it into the papers.”

“If you haven't been a land buyer in the last five years, you probably won't be one now,” says Darrell Hylen, real estate sales associate with Wingert Realty and Land Services, Mankato, MN. “We're still not seeing any indication that we've topped out, price-wise, and I expect to see a strong land market throughout this winter.”

Hylen says good land in the south-central part of the state where he does most of his business is selling for well over $3,000/acre, with some hitting $3,500/acre this past year. He adds that 70 to 75% of those sales have been to farmers looking to expand their operations. “We also occasionally see some relatives who are interested in investing in land, who buy it and then rent it to family members still farming,” he says. “But there isn't that much speculation buying here. Most of our buyers are making a long-term investment.”

Last year only about 2,000 ag land sales took place within the state of Minnesota, Taff notes. “That's only about 2% of the total farmland within the state,” he says.

This is supported by Duffy's Iowa survey, which shows that the percentage of land transactions hasn't varied more than a few points from year to year.

“There's just a set amount of land,” Hylen adds. “Most of the time, a farm only comes up for sale every 50 to 55 years, so you just don't see lots of land on the market at any one time.”

However, a greater percentage of farmland could come on to the market in the coming decade — in Iowa at least. The Iowa survey reports that 48% of Iowa's farmland is now owned by people over the age of 65.

Urban sprawl

When you look at farmland price trends throughout the Midwest, you'll see the greatest increases over the last 10 to 15 years in states with growing metropolitan areas, such as Illinois, Indiana, Ohio, Michigan and Wisconsin (see chart on page 10). Taff claims urban sprawl is the major factor. “The result is that farmers on the edges of these growth areas are selling their land at developer prices and moving out farther and buying as much land as they can,” he says.

“Even those older farmers, close to retirement age, are using the 1031 exchange exemption to avoid capital gains tax,” he explains. That exemption requires the seller to buy land for comparable use within a set period of time after the original land sale.

Taff cites recent sales of farmland on the southern edge of the Twin Cities metro area where prices paid by developers ranged anywhere from $10,000 to nearly $20,000/acre. “Farmers making that kind of money on a sale of, say, 200 acres can turn around and buy 1,000 acres out 70 to 100 miles away, and they're often willing to pay more for the right piece of land,” he says. “That tends to help inflate local prices.”

Different from the early '80s

Record-high land costs, like that of the recent Illinois auction, may lead you to believe land costs have zoomed out of proportion. Even the average farm real estate value for Illinois hit an all-time high this year of $2,610/acre, and $2,770/acre in Indiana. But once such a figure is adjusted for today's inflation level, it's quickly evident that today's record prices are “nowhere near the adjusted land values of the early '80s,” Duffy says.

For example, Duffy explains, the 2003 average per-acre value of farmland in Iowa reached $2,275. That is just above the previous record of $2,147 reported in 1981. But when adjusted for inflation, that 1981 peak amount would equate to about $3,900 an acre at today's rates.

Another major difference between buying land now and buying land in the early '80s is that farmers generally aren't as overextended as they were several decades ago. “Today they are financing 50 to 70% of a land purchase versus 90% of it,” says banker Thiesse. “And of course it also helps that interest rates are much lower now.”

Government programs also have become a strong factor in land values in recent years, Duffy adds. “The '96 Farm Bill was structured more around emergency payments, compared to the 2000 Farm Bill, which continued favorable government payments,” he says. “With the outcome of the recent presidential election, and no change in the administration, we can likely expect more of the same farm policies for the next four years.”

Buying strategies

So what are your best strategies for making a land purchase in the coming year? According to Duffy, the first question you should ask is, Should I buy land?

“You need to know that you have the financial and operational strength to make a land purchase cash flow before you start looking at available parcels,” he says. “You don't want such a purchase to put undo stress on the rest of the operation.”

Today's high-priced land may not pencil out when you look at it separately, on a single-acre basis. “You have to look at your total land costs and how the new parcel would average into your total costs,” Duffy says.

Experts say that once you've decided that expanding your owned acreage is feasible, you should consider the following important points:

New land and the big picture

You need to consider how farming more land will fit into your existing operation, Duffy says. “Is the location a good fit? Does its cropping history limit you in any way?”

Smaller may be better

Be willing to consider buying smaller parcels of land, Hylen advises. “Often, you can get better-quality land for a little less in smaller tracts simply because most farmers want to buy the bigger pieces,” he says. “Especially for smaller farmers, it may be a better fit to start smaller, and you may even get a better land for the money.”

No real deals anymore

Don't expect to find better deals on land by simply moving farther away from urban areas, Hylen says. “Land certainly gets cheaper, but we've found that all land seems to have increased in value at about the same rate, proportionately. So it doesn't seem to matter where you're looking — southern Minnesota, Iowa or South Dakota. Land prices have been consistently going up at about the same level in all those areas,” he says.

Make realistic projections

It's important to remember that not all the economic factors will stay just as they are now when calculating your income projections from a new land purchase, Thiesse notes. “You can't expect that land values will continue to inflate at this rate for much longer,” he cautions. “There will likely be some type of adjustment in the next few years. So you should consider what will happen if there is a 10 to 20% adjustment in land values and what that would do to your total land portfolio.”

Do your homework

Make sure you find out all you can about any piece of land before you make an offer, Thiesse says. “Find out about production history, go to the county and look at drainage and tile maps and soil maps, find out about fertility levels and if a lot of manure has been applied in recent years, talk to neighbors,” he recommends. “All of these things will influence the value of the land, and you need to know just what you're getting.”

Keep a cool head

With such fast-paced sales and limited land-buying opportunities, it can be easy to feel rushed, Duffy notes. “Don't get caught up in the emotion of the moment,” he says. “Most farmers only buy land two to three times in their lives, so it's important to keep a cool head. If you've done your homework and know exactly what you're bidding on, that's easier to do.”